Synergy at Work

In a joint venture, the combined result is greater than the sum of individual efforts

A joint venture is an association of two or more people or entities to carry out a business enterprise for profit. The participants are known as the joint venturers. These people or entities generally combine their property, money, skills and knowledge for the common benefit of the joint venture in its business purpose.

A joint venture usually is formed to undertake a specific business pursuit. It is similar to a partnership, but a partnership relates to a general business and a joint venture relates to a single or limited number of business transactions. A traditional joint venture arises out of a contractual relationship between the parties. The contract may be oral or written, expressed or implied.

Contractual joint ventures must be contrasted with what in recent years has been described as an equity joint venture. An equity joint ventures is not a joint venture in the eyes of the law. Rather, it is a way to describe a separate legal entity created by two or more investors for the purpose of engaging in a stand-alone business.

Such entities are corporations, limited liability companies and similar commercial entities. For example, if two investors decide to form a new company with each contributing capital and receiving stock in exchange, they may refer to their business relationship as an equity joint venture, but the entity created is a corporation, and they, in reality, are stockholders.

Before forming a joint venture, there are many factors to consider. Ensure the cultural values and corporate philosophies of the proposed members are compatible. Make certain there are no conflicts of interest that might jeopardize the business relationship. Consider and evaluate the business reputations, performance histories, pending legal actions, existing workloads, bonding capacities and financial statements of the other proposed members.

Learn as much as you can about the proposed members. For example, do the proposed members have mutually beneficial levels of experience and expertise? Are the groups technologically compatible? Will there be a joint venture leader? What is the financial history of the proposed members? These are important areas of inquiry.

Legal considerations need to be addressed when forming a joint venture. For instance, the parties should decide what law governs the relationship and how changes in law will be addressed. Will there be a sharing of technology that requires a license? Do the parties need to restrict access to proprietary business information, and should a confidentiality agreement be put in place?

In addition, depending on the form of the joint venture, there may be licensing and registration issues that must be dealt with. A separate insurance evaluation should be performed on behalf of the joint venture. A word of caution: It is not appropriate to enter into a joint venture for the purpose of restricting competition in the marketplace. This would expose the joint venture members to possible violations of the antitrust laws, including potential civil and criminal penalties.

One of the biggest advantages of a joint venture is the ability to pool resources, so members can undertake larger and/or more complex projects, than they otherwise would be able to individually. It also facilitates the spreading of risk and the ability to tap into each other’s special skills. Joint ventures can help companies enter new markets, increase their ability to raise capital, take advantage of local knowledge and increase their bidding power and bonding capacities by joining forces.

According to the law

A joint venture, as a legal concept, is of relatively recent origin. At one time, a joint venture was regarded merely as an informal kind of partnership. However, various courts now have developed rules regarding joint ventures that may or may not apply to partnerships.

The requisites to form a joint venture are not firmly established in all jurisdictions. Generally speaking, among the elements that various courts have recognized as being essential to the formation of a joint venture are the following:

Consent to form a joint venture

A fiduciary relationship between the members

A community of interest in the pursuit of a common purpose

Joint proprietary interest in the subject matter

A mutual right of control

A right to share in the profits

A duty to share in the losses

Other elements common to the formation of joint ventures are the contribution by each party of capital or assets to the venture together with a requirement that the assets be held and accounted for, jointly, while the enterprise is being carried out.

A joint venture normally commences on the date the joint venture agreement is signed and may be terminated by the mutual consent of the parties, upon the accomplishment of the purpose of the venture or by default of a party. The principal legal consequence of a joint venture is that each member of the venture is liable for any damages caused.

In the construction industry

One of the reasons contractors enter into joint ventures is to combine their size, skill and financial strengths—including bonding capacities—to bid and perform projects that they otherwise would not be able to perform. Under this type of arrangement, it is wise to enter into a written joint venture agreement as soon as possible. Factors to consider in drafting such an agreement include the following:

Defining the purpose of the venture

Naming the venture

Agreeing on the cash and other property that will be contributed by each party to the venture

Defining the rights, duties and obligations of each party to the venture

Defining the ratio of ownership and the formula for computing the share of the profits or losses to be borne by each party

Specifying the individuals who have authority to act on behalf of the venture

Determining how equipment, labor and material obligations will be satisfied

Identifying any dedicated personnel and/or sole source providers

Specifying how disputes between joint venturers will be resolved

Defining what constitutes a default under the joint venture agreement

Prohibiting fellow venturers from assigning their positions or withdrawing from the venture without the approval of all other parties

In the absence of an agreement to the contrary, joint venturers are presumed to bear any losses sustained in the venture on the same basis as the profits are divided. Moreover, the members of a joint venture generally can be sued, on an individual basis, and found liable for damages caused by the joint venture.

Contractors who enter into joint venture agreements should carefully scrutinize their insurance policies for limitations on liability. In particular, most standard comprehensive general liability insurance policies now contain an exclusion relating to joint ventures. The language most often appearing within the policies excludes coverage for bodily injury or property damage arising out of the conduct of any joint venture of which the insured is a member, but which is not designated in the policy as a named insured.

From the standpoint of legal responsibility, a joint venture continues to exist for as long as it can be found liable for damages arising from the joint venture’s activities. Thus, it is important to designate as a named insured under your comprehensive general liability insurance policy all joint ventures your company enters into, even a dissolved joint venture, if you wish to secure the benefits of the “completed operations” liability coverage under your policy.

Joint ventures, like other entities, often are required to furnish payment and performance bonds in support of their work. It is common practice for sureties to underwrite the finances and capabilities of the counterparts to a joint venture and to prequalify the joint venture in its entirety.

However, sureties do not look favorably upon arrangements where one contractor “lends” its balance sheet to another for surety capacity, when the lending contractor has no real involvement in the management and execution of the bonded work. Sureties will look at the combined financial strength and histories of performance of the members to a joint venture in determining the amount of bonding capacity that will be offered to the joint venture. Basic surety underwriting standards will apply, which means sureties are looking for quality financials, capital retention, plus corporate (and possibly personal) indemnities for potential surety exposures. Sureties are less likely today to assume the risk of large multiyear projects on their own. Such projects more frequently involve cosureties and/or segmented bonding (i.e., different sureties bonding different segments of a long-term contract). Thus, if you are forming a joint venture to pursue such projects, pay special attention to the bonding arrangements.

Finally, because a joint venture is a contractual relationship, the joint venture agreement can be enforced between and among the individual parties. Joint venturers normally can take actions against each other for breaches of the joint venture agreement and may also seek indemnity, from each other, for liability to third parties where the joint venture agreement purports to release one or more joint venturers from such liability. EC

FERGUSON is a partner in the Boston law office of McCarter & English LLP. He is a former electrical contractor with a national practice in construction law. Contact him at wferguson@mccarter.com or 617.449.6561.